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Investing.com -- European property stocks have taken another hit as analysts at Barclays (LON:BARC) downgraded key players in the German residential sector, citing weak cash flow dynamics and increased refinancing risks.
The downgrade includes LEG Immobilien, which was previously the only overweight stock in the sector, now moved to equal weight.
The revision reflects growing concerns over leverage, refinancing at higher interest rates, and weakening investor sentiment toward German residential real estate.
Barclays analysts have consistently argued that German residential companies should operate with zero debt, given that their free cash flow yields before financing costs remain significantly lower than marginal borrowing rates.
The failure to address this issue has made the sector unattractive, despite hopes that asset values had stabilized.
At the same time, Germany’s increased government investment has eased fears of an economic downturn, weakening the case for holding residential property stocks as a defensive strategy.
While a renewed recession risk—especially in light of trade policy uncertainties under the Trump administration—could bring some investors back to the sector, Barclays analysts prefer exposure to Swiss real estate stocks like PSP and SPS for defensive positioning.
The downgrade of LEG Immobilien reflects a shift in expectations. Barclays initially rated LEG as overweight on the assumption that the company would pursue equity-funded growth.
Instead, LEG chose to finance its acquisition of the remaining two-thirds of BCP with debt, a move poorly received by investors due to its impact on leverage and AFFO (Adjusted Funds From Operations).
The stock has underperformed the sector, prompting Barclays to cut its price target for LEG by 30%, lowering it to €70 from €100.
Other major German residential stocks remain under pressure. TAG Immobilien remains at EW, with its Polish build-to-sell portfolio seen as a positive factor. However, concerns remain about the company’s cash flow dynamics, with an ungeared AFFO yield of just 2.2%, still below its marginal financing cost of around 4.5%.
Barclays also notes that TAG’s higher asset yield, while making it relatively defensive, could be linked to lower-quality locations, limiting rental growth potential.
Grand City Properties remains “underweight,” despite a higher AFFO yield compared to peers.
The company’s leverage is slightly lower than that of LEG and Vonovia, but governance concerns persist due to its majority ownership by Aroundtown, a highly leveraged company that consolidates GYC in its accounts.
Barclays analysts are also wary of GYC’s investment in an external fund alongside Aroundtown, adding another layer of uncertainty to its financial outlook.
Vonovia, Germany’s largest residential property company, also remains underweight. Barclays sees little appeal in its AFFO yield and is skeptical of the company’s strategy to drive EBITDA growth through capital-intensive investments.
Vonovia has outlined plans to increase EBITDA by €575 million to €875 million by 2028 through various initiatives, including value-add services, recurring sales, and development projects.
However, Barclays notes that this so-called "capital-light" strategy still involves raising annual investment levels from €836 million in 2024 to around €2 billion by 2028.
Increased tax burdens and higher investment needs are expected to offset much of the projected EBITDA growth, leading Barclays to revise its AFFO forecasts downward.
However, J.P. Morgan analysts suggest that shifting bond yield trends could be turning into a tailwind for the sector.
The broader European real estate market has been reacting positively to the continued decline in property bond yields, as expectations for ECB and BOE rate cuts have been pulled forward. J.P. Morgan analysts argue that even removing the buffer in cost of capital assumptions could boost fair value models for leveraged companies like Vonovia and LEG, potentially implying over 40% upside from current levels.
The market reaction has been particularly strong for highly leveraged firms and those with shorter debt maturities.
Companies such as Kojamo (HE:KOJAMO), Vonovia, Aroundtown, and Castellum have seen strong gains, reversing previous concerns around their debt burdens.
However, European mall operators like URW and Klepierre (EPA:LOIM) have not participated in this rally, reflecting lingering uncertainty over consumer spending trends.
Self-storage companies, despite their lower leverage, have also performed well, which J.P. Morgan analysts find somewhat surprising given their sensitivity to broader economic activity.
While Barclays flags ongoing concerns over leverage and cash flow constraints, J.P. Morgan suggests that a more favorable bond yield environment could change the narrative.